The Economics of Trust

I have previously argued that the economy cannot recover until we restore trust in our government, our leaders and our systems. This essay provides further evidence in support of that argument.

The Economics of Trust

Forbes wrote an article in 2006 entitled “The Economics of Trust”. The article summarizes the importance of trust in creating a healthy economy:

Imagine going to the corner store to buy a carton of milk, only to find that the refrigerator is locked. When you’ve persuaded the shopkeeper to retrieve the milk, you then end up arguing over whether you’re going to hand the money over first, or whether he is going to hand over the milk. Finally you manage to arrange an elaborate simultaneous exchange. A little taste of life in a world without trust–now imagine trying to arrange a mortgage.

Being able to trust people might seem like a pleasant luxury, but economists are starting to believe that it’s rather more important than that. Trust is about more than whether you can leave your house unlocked; it is responsible for the difference between the richest countries and the poorest.

“If you take a broad enough definition of trust, then it would explain basically all the difference between the per capita income of the United States and Somalia,” ventures Steve Knack, a senior economist at the World Bank who has been studying the economics of trust for over a decade. That suggests that trust is worth $12.4 trillion dollars a year to the U.S., which, in case you are wondering, is 99.5% of this country’s income. ***

Above all, trust enables people to do business with each other. Doing business is what creates wealth. ***

Economists distinguish between the personal, informal trust that comes from being friendly with your neighbors and the impersonal, institutionalized trust that lets you give your credit card number out over the Internet.

America in the last 7 years or so has undermined both personal trust in our leadership (Bush, Cheney and Congress are the least popular president, VP and congress in history). Moreover, Americans trust in our institutions – institutionalized trust – has also collapsed.

Surveys show that Americans’ trust in our government and in governmental and financial systems has plummeted after the government’s failure to stop the 9/11 attacks, lying about Iraqi WMDs, letting New Orleans drown in Hurricane Katrina, spying on Americans and torture.

Americans no longer trust the politicians, the justice system, their ability to obtain liberty, or the media. They sure don’t trust the bankers and the financial bigwigs, who they rightfully blame for bringing on the financial crisis.

Indeed, if our leaders aren’t following the Constitution or the rule of law, and are lying about what they’re doing, why should we believe that they are enforcing the rules of a free market? Everywhere we look, we see that those with power act as if they were above the law. It is true of banks and Wall Street giants, as well as politicians.

Many people may not know it yet, but the current financial crisis will likely be worse than the Great Depression. See this and this. It will be the worst financial crisis America has ever faced.

Is it any coincidence that it is coming during the same time frame in which the Constitution, the rule of law and international law on torture and warfare have been abandoned? I don’t believe so. I believe that the collapse of trust from all of these events has created a crash of the most important bubble of the last 200 years: the idea of government by laws instead of arbitrary people, of representative government, and of a free market. All of these innovations occurred in the 18th century.

The bubble created by the Constitution and the Bill of Rights, Adam Smith’s idea of the free market – and all the prosperity which those ideas enabled – has popped. (It may just be coincidence, but it is interesting that Elliot Wave theorists are predicting that we are ending a larger cycle which started in 1718, and that we could crash all the way back to that point. 1718 is right before Adam Smith wrote about the free market and the Founding Fathers wrote the Constitution and formed America).

Unless we try and convict those responsible for attacking the Constitutional form of government and the free market, we cannot restore trust.

Afterword: Trust by Other Countries

As an afterword, it should be remembered that foreign investors in America – like China, Japan, Saudi Arabia, the UAE and others – invested in the U.S. because they believed that the U.S. economy was strong and that the financial systems were both efficient and transparent. As Peter Schiff and others have warned for years, foreign investors will start pulling out of the U.S. economy when they figure out that it is built on a house of cards.

That is now happening.

China’s sovereign wealth funds will cut way back on their U.S. investments. The same is true for Saudi and other investors. Now that they finally understand that America’s seeming wealth was a house of cards and that they cannot trust American accounting, they no longer want to do as much business with America.

Until America restores trust by speaking accurately about what is occurring, foreign investors will not want to invest large sums of capital in America. Indeed, no one wants to invest in a banana republic . . . and the U.S. has become a banana republic.

Telling the truth about torture, war-lies and 9/11 is a good start (in addition – obviously – to making accounting and rating transparent). For the rest of the world knows the truth, and seeing the U.S. honestly address these festering wounds will help them regain trust in America.

For those who point out that the crisis is worldwide, I would agree. Financial manipulation is not limited to America, nor is torture, or false flag terror. The points in this essay apply, to varying degrees, to the rest of the world as well.

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